A lot of 401(k) investors end up making the same mistakes when choosing their investments. The results are low returns and unbalanced portfolios. Avoiding these four mistakes is a good start for getting more out of your 401(k).
Mistake #1: Going Overboard on Risk Avoidance Many 401(k) plan participants are either overwhelmed by the list of investment choices or are simply afraid to take any risk in their investments, and so put all of their savings into a money market or stable value fund. Sometimes the money market fund is the default option for their employer's plan – – meaning their money ends up there, earning very low interest. Nobody bothers to change it.
Mistake #2: The Equal Allocation Trap Another common mistake made by investors in their 401(k)s is to invest an equal portion into each available investment option. This is called the 1/N Rule. First, you do not need to invest in every option available in your plan. Especially now that target date retirement funds (mutual funds that change allocation based on your estimated retirement date, growing more conservative as you age) have become popular, you do not need to invest in every bond fund and every stock fund to achieve diversification. Also, each investment option has been selected based in its individual characteristics, not based on how all of the options work together.
Mistake #3: Too Much Company Stock Many companies allow employees to purchase company stock in their retirement plans. As tempting as it might be to bet on a company you know very well (hey, you work there, right?), you should minimize your investment in company stock. Remember Enron, Bear Stearns and Lehman Brothers? Those employees lost their jobs and their retirement savings in one day when their companies went bankrupt
Mistake #4: Eschewing Small–cap and International Stocks When you enroll in a 401(k) plan, your employer should provide you with the recent performance of every investment option in the plan. Most investors are naturally risk–averse, and shy away from investment options that have been down recently. The performance of small–cap and international stocks has been less than domestic large–cap stocks recently. But these funds are still excellent choices for increasing portfolio diversification. They have characteristics that can improve the overall returns and lessen the volatility of your portfolio.